Corporate actions are very important in determining the future of a firm in business and finance. The corporate action life cycle would be very helpful in informing one about the ethical nature and financial health of a company.
The blog discusses corporate action processing and its effects on stock prices. For example, what would happen if bonus shares are issued?
What Are Corporate Actions?
Corporate actions are decisions or initiatives that a company's Board of Directors takes with the approval from its shareholders, considering the shareholder decisions. Most corporate actions signal an important landmark which would be able to affect the corporation's structure, operation, and/or stock price. Changes include simple ones, like renaming, or major decisions, such as declaring dividends.
Corporate actions can be categorized into two classes: monetary and non-monetary.
Monetary actions affect the company and its shareholders in financial terms. For instance, a declaration of dividend directly affects stock prices and shareholder returns.
Non-monetary actions do not have direct financial implications. For instance, changing the company's name or logo is a non-monetary corporate action.
Important Corporate Actions with Financial Implications
We will, in the following section, discuss five major corporate activities which have a direct impact on the corporation's financial position as well as shareholders' worth.
Key Corporate Moves and Their Impacts on Share Prices
The corporate moves of a company have a lot to do with the action of its stock performance in the market, as well as its shareholder value. Let's analyze three key corporate moves and their impact on the market.
1. Profit Distribution (Dividends)
A dividend is a way whereby companies share profits with their shareholders. In the form of either per-share basis or percentage face of the share, it assures investors of current income.
Example:
In December 2020, Majesco announced an interim dividend of ₹974 per share. Then, the stock was trading above ₹980 per share. After a dividend declaration, the share price moves according to the same, falling from ₹985.65 on 21 December 2020 to ₹12.20 on 22 December 2020. This is natural since the payout decreases the retained earnings of the company and thereby its stock price.
2. Issue of Extra Shares (Bonus Shares)
A bonus issue of shares is a term where additional shares are distributed among existing shareholders at no extra cost. For instance, the phrase 1:1 bonus is an example where one share for each shareholder shall be issued.
Effect on Value:
With an increase in the number of shares owned, there is a corresponding reduction in value per share without the change in total investment value. In essence, the stock becomes less expensive and more appealing to small investors.
Illustration:
Astral Poly Technik, a leading plastic pipes company, had a record date set as March 19, 2021, through a 1:3 bonus share issue. The shareholder gets one additional share for each three shares held. While the numbers rose, the price per share diminished to keep the value of investment essentially the same.
3. Split of Shares (Stock Split)
This divides existing shares into smaller units so that the total number of shares available increases, without affecting the investment value. The practice is commonly used to make stocks at a higher price level more accessible to more investors.
Impact on Market:
For the illustration, suppose the stock has undergone a 1:2 split, then the shareholder holding shares worth ₹10 each is given 25 shares having face value of ₹10. After the split, he holds 50 shares whose face value is ₹5 per share. The value of the investment remains the same, while the decreased price level makes for more trade and enhances market liquidity.
Example:
The company with pricey shares, Eicher Motors, declared a 1:10 stock split effective from August 24, 2020. The pre-split share price was ₹21,700. It has dipped to ₹2,300 a share, hence easy to trade for investors, increasing participation in the market.
4. Issues of shares to existing shareholders- Rights Issue
Rights issue permits a company to raise new share issues solely to the existing shareholders instead of the general public. These are unlike bonus shares since their purchase is chargeable; the price often is relatively low. An example of rights issue is the 1:5 rights issue where an investor can purchase one additional share for every five held.
Why It Is Done
Companies typically opt for rights issues to finance expansion schemes or pay off debts. Nonetheless, one must study the company's future before investing.
Illustration:
Reliance Industries had a rights issue in April 2020 at a 1:15 ratio. The shareholders were allowed to purchase one share for every 15 held at ₹1,257 per share, which is 14% below the closing price on April 30, 2020.
5. Share Repurchase (Buying Back Shares)
Share buyback happens when a company purchases some or all its shares issued to investors at a premium. This helps to reduce the common stock, increase earnings per share, and convey a good signal about the company's future.
Why It's Useful:
Buybacks can be used for various purposes:
- Strengthen the control by consolidating ownership.
- Prevent hostile takeovers.
- Supporting share prices during a sharp market decline.
- Building investor confidence in the management team.
Example:
GAIL launched a buyback of around 6.97 crore shares on February 25, 2021, at ₹150 per share. The date for eligibility for the purpose was January 28, 2021. The company funded the buyback from internal cash reserves.
FAQs:
1. What are corporate actions and why are they important?
Corporate actions are any plans initiated by the Board of Directors that the management may implement in their operations, structure, or stock price. They give deeper insight into the financial condition and strategic direction of the company.
2. How does a declaration of dividend affect the price of a stock?
Generally, declaration of dividend declines the prevailing current stock price through the declared dividend amount as the retained earnings are stripped off the business.
3. How does bonus shares differ from rights issues?
Bonus shares are distributed without any payment, whereas a rights issue permits shareholders to purchase further shares at reduced prices.
4. In what ways does stock split advantage the investor?
The stock split brings down high-valued shares into affordable and therefore increases the participation in the market as well as liquidity without increasing the overall value of investment.
5. How does a declaration of a dividend affect the price of a stock?
In general, when a dividend is declared, it reduces the present stock price by the amount declared as the declared dividend reduces the retained earnings of the business.
Conclusion
Understanding the impact of corporate moves is important to value a company, make an informed investment decision and effective portfolio management.
For example:
A rights offering would reduce the prices of shares in the short run because of increased share supply.
A buyback would increase share prices in the short run as a result of share scarcity.
By analyzing these moves, investors can effectively hold, buy or sell their shares.
Corporate actions can be included in investment strategies to allow an investor to make the best decision. For further knowledge of corporate actions and what they bring about, take an investment banking course to help sharpen your skills and strategies.
